World Poverty and Economic Growth John Wallis Department of Economics University of Maryland

Modern Economic and Political Development The two graphs that follow plot very rough estimates of real income per capita over the last 3,000 years and the level of world population over the last 11,000 years. The two graphs show the same pattern: a rapid increase in both income and population after 1800, and not much before. They are often called “hockey stick” graphs.

Greg Clark, Farewell to Alms

World Population Source: R.W. Fogel, “Catching Up with the Economy,” AER (1999)

Something obviously changed about 200 years ago. Before then, the long run rate of per capita income growth was very close to zero, and most increases in income were taken up in the form of population.

Per capita Income Per capita income in the United States in 2012, in 2012 dollars, was roughly $50,000 Over the very long run, since 1840, per capita income in the United States has grown at roughly 1.5% per year. Using the “rule of 72” that means per capita income in the US doubles about every 50 years.

Per Capita Income in US, 2012$ 2012$50, $25, $12, $ 6, $ 3, $ 1, In 2012, 12 countries had per capita income of less than $1,062.50; and an additional 19 countries had per capita income less than $2,000; and another 16 countries had incomes less than $3, countries have lower per capita incomes than the United States in 1812!

A significant part of the world’s population still lives at a standard of living consistent with the flat part of the hockey stick graph. These societies are extremely poor.

China or Mexico? I often ask my students, where would you rather live, China or Mexico The majority usually say China. Then I ask them where they would have higher incomes? The majority usually say China, but… – $9,055China – $15,363 Mexico China grows faster now, but Mexico is richer.

Which grow faster? Rich or poor countries? It seems obvious that rich countries grow faster over the long term than poor countries, and in a sense that has to be true. But do rich countries grow faster when they are growing than poor countries do when they are growing?

Rich countries grow more slowly than poor countries when they grow. The difference over time is not the rate of growth, The difference is the speed with which poor countries shrink when they are not growing and the proportion of years in which they shrink. The poorest countries grow and shrink at almost the same rate, and they only grow in 56% of years.

Two Development Problems How can we explain this? We need to understand that there are two development problems. The first development problem is how did countries like the United States manage to grow so steadily after 1800 or so. This process applies in about 25 countries with roughly 15% of the world’s population.

The second Development problem The second development problem is how do societies (or countries) acquire the ability, or the institutions, that enable them to avoid the shrinking problem? How do they get to the point where the United States probably was in roughly 1850, where they are able to grow steadily? The second development problem is getting from China (or Congo) to Mexico, the first development problem is getting from Mexico to the US. The US had a civil war in 1861, what about the developing world?

17 Violence and Social Orders: A Conceptual Framework for Interpreting Recorded Human History Douglass North, John Wallis, and Barry Weingast, Cambridge University Press, 2009.

18 The Concept of Social Orders The concept of the social order provides: - A framework for understanding how violence is contained. - A framework within which we can simultaneously understand the operation of the political, economic, and other social systems. There have been three social orders in human history, the foraging order, natural states, and open access orders. We want to focus on the last two.

19 The Logic of the Natural State The Natural State political system creates economic rents through limited access and then uses the rents to sustain order. The Natural State is a solution to endemic violence.

Rents Rents are a return to an action or choice that is above the amount necessary to get a person to perform the action or make the choice. If your best job opportunity pays $10 an hour, and you get a job that pays you $15 an hour, then you make a rent of $15. As long as you are paid more than $10 you will be willing to work, and anything you make over $10 an hour is gravy (a Rent).

21 Natural States/Limited Access Orders Natural states create incentive-compatible agreements among powerful individuals and groups by recognizing the privileges of each individual to control valuable resources, activities, and organizations. The interaction of these incentives both orders the dominant coalition and limits the use of violence. All natural states are limited access orders.

The Nature of Rents By enabling the formation of larger and better coordinated groups and organizations, the natural state creates rents from increased output and productivity through greater coordination and scale. This is not about maximizing the rents the rich and powerful receive, it is about creating rents that are affected by violence or lack of coordination, and therefore serve as means of limiting violence and promoting coordination. 22

23 The Logic of the Open Access Order Open access orders control violence by consolidating control of violence in a single or small number or organizations: military and police and placing control of the military in a political organization. The subjecting control of the political organization to political and economic competition through open access.

Three pieces Consolidated control of military and police A competitive polity that controls the military, but is (as a result) potentially very dangerous A competitive economy capable of disciplining the polity. Open access – the ability to form organizations at will – is the key to sustainable political and economic competition and, therefore, to the dynamics of the whole social order. 24

The Idea of the Double Balance Open access requires that access to economic and political organizations be open, so entry in economics disciplines the political process, and entry into politics disciplines the economic process. In natural states, limited access to economic and political organizations is similarly self-enforcing. The idea of a double balance is that economic and political arrangements must be consistent with one another, and if they are not, dynamic forces will be set in motion to “restore” (or affect) the balance.

The Double Balance The close connections between economics and politics in developing countries is often perceived as corruption, when it is an inherent part of the social order. The seeming independence of economics and politics in developing countries is something of an illusion, since it ignores the deep connections between the two in an open access society.

Back to the Two Development Problems For most of the last 60 years, development policy has focused on solving the first development problem: how to make societies like the US and Western Europe. By and large those policies have failed to work, in the sense that they have not produced measurable improvement. We think it is because policies that work in the developed world are consistent with the logic of open access, but not consistent with the logic of natural states.

Impersonal rules The question of why the institutions of developed societies do not work very well, or more accurately, the same way in natural states is a deep and complicated one. These include elections, representative governments, courts, and free markets. Impersonal rules, rules that treat everyone the same, are an important feature of open access societies (although not all rules in open access societies are impersonal), yet they seem to be very difficult for developing societies to implement.

Elites and Corruption All societies have elites, including the United States, Russia, and Congo. In open access societies elites are subject to the same rules and the same enforcement as everyone else. In natural states, elites are often subject to different rules, and even when the rules apply to them, they are often able to subvert the enforcement of the rule. We usually call this corruption.

Why can’t natural state enforce impersonal rules? NWW lay out the logic of how societies are able to limit violence and order relationships between powerful organizations through the creation and manipulation of rents. To see how the logic of the natural state works, think of two groups that always fight (this is a too simple example, but it works). How can leaders emerge that can credibly promise not to fight?

AB a a a b b b

In these arrangements, A and B are clearly better off, they get a large share of the rents. But the a’s and b’s are also better off, in the sense that there is less violence (a big benefit) and they are more productive because their society is larger and better organized. In fact, the benefits from coordination also serve to limit violence, by making the agreement between A and B not to fight more credible.

AB a a a Rentssupport

Rule enforcement We usually think of rules as being enforced by a person (or organization) with a monopoly on violence. Max Weber’s famous definition of the state is the organization in society with a monopoly on the legitimate use of violence. The monopoly on violence is a characteristic of open access societies, but not of natural states. A and B are both potentially violent, and neither has a monopoly on violence.

Third-Party Enforcement The logic of the natural state provides a theoretical framework for understanding how third party enforcement emerges, without beginning with a single-actor endowed with a monopoly of violence. A can serve as the third-party enforcer for rules in B’s organization, and B can serve as the third- party enforcer in A’s organization. Note, however, that the rules will differ in different organizations! They are not impersonal rules.

Identity Rules In fact, the relationship between A and B depends on the fact that A and B are treated differently from the a’s and b’s, and also that A and B themselves are treated differently. The rents that keep the relationship between A and B credible are usually called privileges, A and B cannot share the same privileges, they must have unique identities. In fact, the only rules that natural states can credibly enforced are based on people’s social identity. They are identity, not impersonal rules.

Identity Rules The oligarch’s in Putin’s Russia have privileges and operate under a different set of rules. This is not just because they are powerful, they are powerful because they are part of a coalition, what NWW call a dominant coalition, that limits violence and provides social order. If the oligarchs were treated the same as everyone else, the rents holding the coalition together would fall apart and the result would be violence.

The Second Development Problem Serious poverty at the level of societies is associated with “failed states.” Failed states are societies where arrangements between elites have broken down. Whether civil war is active or not, these societies, indeed all natural states, live in a shadow of violence. Impersonal rules won’t work in a natural state, because they are inconsistent with the logic of the social order.

The second development problem The real problem for most developing countries is not how to make the transition from Mexico to the US, from being a natural state to an open access order. The real problem is figuring out how to organize their societies in ways that provides for order and stability, at the same time that it enables elites to find it in their interest at some point to move toward impersonal rules (the first development problem).